Brazil election tension rises as Fitch sounds warning

After Standard & Poor's downgraded Brazil to BBB- in March, Fitch says it will closely monitor “whether the government stays the course” after the October election

A failure by the Brazilian
government to keep fiscal dynamics under control after the
October election could prompt a downgrade from Fitch Ratings,
the agency cautioned on Thursday.

While defending
Fitch’s BBB rating and stable outlook on Brazil,
future tightening of fiscal policy was "a necessary pill", said
Shelly Shetty, the agency’s head of Latin American
sovereigns. The agency would look at whether the government
"stays the course" of rebalancing its fiscal account, taming
inflation, attracting private investment in infrastructure
— and resisting "raiding" the public-sector banks.

The warning from the rating
agency came as anxiety builds among Brazil investors about the
potential for market volatility to accompany the election.

Still, Brazil enjoyed political
stability and an understanding among policymakers of the
importance of macro-economic stability, said Shetty. But the
agency would monitor events after the elections, she said,
looking for greater fiscal conservatism including public sector
bank lending — which she said would "dictate our
judgments" on the country’s debt trajectory.

"In some ways, Brazil comes out
as one of the strongest in the Fragile Five," she said,
referring to Morgan Stanley’s label for the five
emerging markets it sees as particularly vulnerable to tighter
US rate. "We don’t think Brazil is necessarily
underperforming other key emerging markets."

Fitch took note of
Brazil’s growing macro-economic problems and more
troublesome inflation outlook "a couple of years ago", said
Shetty. This had stopped the agency becoming too optimistic on
the sovereign when Brazil’s weaknesses were less
widely acknowledged than they are today, she said.

Slowing economic growth and
rising inflation were important factors in the
agency’s consideration of risks in Brazil,
according to Shetty. The agency was also monitoring the
deterioration in the state’s primary surplus to
1.9% of GDP last year, and its debt-to-GDP level of 58%
— much higher than the 40% median for triple-B
sovereigns.

Nevertheless, she noted "policy
corrections in the last few months" including higher benchmark
rates, more flexibility on the exchange rate, government
policies to attract more private investment in infrastructure,
and "signals that the government would prevent future fiscal
deterioration".

She also referred to the
country’s large central bank reserves, making
Brazil "one of the strongest creditors in the BBB category"
despite its weak economic growth and high government
indebtedness.